3 Ways to Pay Yourself as a Business OwnerJun 13, 2023
3 Ways to Pay Yourself as a Business Owner
One of the most important things to decide as a business owner is how much to pay yourself. There are countless resources out there that can help you figure out how to align your income with your business’s resources and your personal lifestyle goals.
But there’s another aspect of paying yourself that’s rarely discussed: how to pay yourself. This topic is just as important, but it’s often overlooked in articles and resources for business owners. Once you’ve calculated the amount you’ll make, you need to decide how to transfer it from your business to yourself as income.
When it comes to paying yourself, you’ve got several different options. Let’s look at the advantages and disadvantages of each one so you can start considering which route you want to take in your business.
Understanding the different ways to pay yourself
Essentially, there are three basic ways to pay yourself as a business owner. They’re somewhat tied to the legal structure of your business, and they can have a significant impact on how you pay taxes. So when you’re deciding whether to make your business an LLC or an S Corp, make sure you consider how each structure will affect your personal income.
Most people who are “traditional employees” (e.g., W-2 workers) get paid a salary, and you can pay yourself as a salaried “employee” when you’re a business owner. Paying yourself a salary allows you to withhold money for income taxes, and you can also join your company’s healthcare and retirement plans (if you offer them). In most cases, the owner of an S Corp is required to take a salary.
An alternative to paying yourself a salary is to transfer money from the business to yourself via an owner’s draw. This is usually the default choice for people with sole proprietorships and single-member LLCs. You can’t withhold money on an owner’s draw, so you have to calculate how much to save up for your income taxes each year.
Another option is to pay yourself a portion of the profit that your business makes. If your business has multiple owners, the amount each person gets depends on the size of their “stake” in the company, which is usually defined in the business agreement. If your business is an S Corp, you can take a profit distribution on top of your salary.
Pros and cons of each method
Each type of payment has advantages and disadvantages.
Paying yourself a salary ensures your income is stable and reliable. A salary is considered a business expense, so it shows up on your monthly, quarterly, and yearly P&L statements, which can make your bookkeeping easier.
A salary can also simplify taxes and allow you to participate in your company’s retirement and healthcare benefits. Paying yourself this way may make it easier to get a personal loan — most creditors prefer to see a W-2 when determining creditworthiness.
However, if you want to pay yourself a salary, you need to have predictable cash flow in your business. You can’t pay yourself a salary if your business is an LLC, so it might not be the right option if you’re a solopreneur who’s just starting out.
With an owner’s draw, you have the flexibility to take money out of your business whenever you need it. It can be a good choice if you are a single-member LLC, as long as you have a high level of self-control and good budgeting skills.
However, it can be hard to keep track of owner’s draws in your business’s accounting. These transactions are considered liabilities, not expenses, so they only show up on a balance sheet, not a P&L. If you pay yourself this way, you need to keep meticulous records of your personal and business finances.
Additionally, you can’t withhold taxes if you pay yourself via an owner’s draw, so you need to make sure you’re saving up enough money to cover your tax bill every year. If owner’s draws are your only source of personal income, it can be harder to qualify for a mortgage or car loan.
If you pay yourself via profit distribution, you get to benefit directly when your business succeeds. Depending on how your business is structured, profit distributions may be taxed more favorably than owner’s draw or salaries. And you can choose when to take a profit distribution, which gives you more flexibility than a salary.
However, that flexibility can also mean your income is inconsistent. And you might not be able to pay yourself very much during times when business is slow or expenses are unusually high. Additionally, there aren’t always tax advantages to profit distribution, and this option can make taxes more complex. Finally, if you have more than one owner, figuring out each person’s share can potentially be challenging.
Talk to an accountant about your payment options
As you can see, every option you have to pay yourself comes with its own benefits, drawbacks, and nuances. It’s imperative to work with a financial professional (like an accountant) to figure out which option provides the most advantages for you and your business. You might start out paying yourself one way and decide to change it later when your business grows. For example, if you outgrow a single-member LLC and restructure as an S Corp.., you’ll have to pay yourself a salary.
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